Abstract
New Zealand: Selected Issues
New Zealand—Options for Tax Policy Reform1
New Zealand’s low national savings rate—a longstanding feature of the economy—is a source of vulnerability and likely contributes to relatively high interest rates needed to attract foreign capital. Moreover, some features of New Zealand’s tax system also underpin high demand for housing and can amplify price movements, resulting in high prices and the danger of a self-reinforcing spiral. This paper explores options for tax reform to address both issues.
A. Introduction
1. New Zealand’s economy has performed well in the aftermath of the global financial crisis (GFC). Growth rebounded quickly, supported by strong economic policy fundamentals, rising terms of trade, reconstruction after the 2010-11 Canterbury earthquakes, and more recently high net immigration. However, in 2014, the terms of trade have begun to decline, and growth has started to slow. Nonetheless, house price inflation in Auckland continues at high levels.
2. A large saving-investment gap has been a long-standing feature of New Zealand’s economy. With low public debt, fiscal consolidation broadly on track and high public sector savings, it is the saving deficit of the private sector that is leading to persistent current account deficits, which are covered to a significant extent by bank borrowing. Net international liabilities have declined but, at 65 percent of GDP in 2014, remain high and are projected to increase again.
3. Low saving is a source of vulnerability and raises borrowing costs. New Zealand’s economy is dependent on international investor confidence, making it susceptible to swings in international financial markets, and leading to higher capital costs (Brook 2014). Indeed, interest rates in New Zealand tend to be higher than in other advanced economies. Moreover, the composition of household savings—largely invested in real estate—tends to drive up house prices and amplify price movements, with attendant risks of a self-reinforcing spiral, and may crowd out business investment.
4. New Zealand’s persistent saving-investment gap cannot be explained by macroeconomic policy settings. Previous cross-country studies (IMF 2013) show large one-sided residuals when attempting to explain New Zealand’s current account deficit and private saving rate by factors such as per capita income, population growth, age dependency ratio, terms of trade, expected income, social insurance, the budget balance, and others. This implies that idiosyncratic structural factors are the main determinants of New Zealand’s low saving rate and high current account deficits.
5. This paper analyzes elements of New Zealand’s tax and benefit system that could help explain low private savings and their composition, and offers reform options. In particular, the impact of the voluntary Kiwisaver scheme, New Zealand’s pension (‘superannuation’) system, and the structure of the tax system are examined. The paper then offers interrelated reform options. The remainder of this paper is organized as follows: Section B discusses salient features of New Zealand’s tax and benefit system; Section C offers three reform modules, each comprising a number of individual measures; and Section D concludes.
B. Taxes and Benefits
General Observations
New Zealand’s tax system is simple and efficient, and imposes an overall smaller burden on the economy than in most other advanced economies.
6. New Zealand’s overall burden of government levies, at 35 percent of GDP, is very low, and revenues are skewed toward more efficient indirect taxes (Figure 1).1 Its total levy-to-GDP ratio is 8¼ percentage points lower than the average of advanced-economy peers (Figure 1). The overall level of indirect taxes on goods and services as a percentage of GDP is somewhat higher than in other OECD economies, while revenue from direct taxes is low.
Revenue Composition
Citation: IMF Staff Country Reports 2016, 040; 10.5089/9781475522549.002.A003
Sources: OECD, IMF.Revenue Composition
Citation: IMF Staff Country Reports 2016, 040; 10.5089/9781475522549.002.A003
Sources: OECD, IMF.Revenue Composition
Citation: IMF Staff Country Reports 2016, 040; 10.5089/9781475522549.002.A003
Sources: OECD, IMF.7. Three taxes generate over 90 percent of total tax revenue (Tax Working Group, 2010). The largest revenue earners are the personal income tax (53 percent), the goods and services tax (GST; 21 percent), and the corporate income tax (17 percent).
8. New Zealand’s tax system epitomizes the principle of ‘broad base and low rate’ taxation.
The personal income tax is only moderately progressive (Figure 2). There is no tax-free threshold, the introductory marginal rate is 10.5 percent, and the maximum rate is 33 percent. This puts New Zealand close to the average of peers’ tax rates at that income level, but the absence of a tax-free threshold is fairly unique (though low-income households can receive tax credits and transfers that more than offset their tax burden). While relatively efficient in terms of reducing disincentives to work, it also does little to reduce inequality, in particular given the relatively small size of the state and hence redistributive capacity through benefits (see below).
Income Tax Progressivity
Citation: IMF Staff Country Reports 2016, 040; 10.5089/9781475522549.002.A003
Income Tax Progressivity
Citation: IMF Staff Country Reports 2016, 040; 10.5089/9781475522549.002.A003
Income Tax Progressivity
Citation: IMF Staff Country Reports 2016, 040; 10.5089/9781475522549.002.A003
The GST rate is relatively low, but its productivity is extremely high (Figure 3). Introduced in 1986 at a single rate of 10 percent, it was later increased to 12.5 percent (1989) and 15 percent (2010). It has almost no exemptions. Most notably, food is included at the full rate, leading not only to a broad base but also to reduced compliance and administration costs, as definitional issues that afflict more complex systems are avoided. As a result, New Zealand has the highest sales tax productivity in advanced economies (with the exception of Luxembourg, where significant cross-border sales boost VAT productivity). On the other hand, the taxation of food at the full rate (which most peer countries avoid) puts a relatively high burden on lower-income households who spend relatively more on such items.
GST and Corporate Taxes
Citation: IMF Staff Country Reports 2016, 040; 10.5089/9781475522549.002.A003
GST and Corporate Taxes
Citation: IMF Staff Country Reports 2016, 040; 10.5089/9781475522549.002.A003
GST and Corporate Taxes
Citation: IMF Staff Country Reports 2016, 040; 10.5089/9781475522549.002.A003
Corporate taxation is low. While the corporate income tax rate, at 28 percent, is above the OECD average, compulsory contributions to employee savings (through the Kiwisaver scheme)—the incidence of which, in any event, is likely to fall largely on employees—are small, rendering the overall tax burden on corporates low.
9. Despite these features, inequality in New Zealand is moderate and has declined over the past ten years (Figure 4). While broad bases at low rates are efficient economically, they tend to weaken the redistributive mechanism as the difference in taxation between high- and low-income earners is limited (though this can be counterbalanced through increased transfers to low-income earners). However, New Zealand’s inequality outcomes, while higher than in European countries, on the whole do not appear to bear this out. To a significant extent, this is due to the relatively low pretax/transfer inequality, implying that to reach a given level of post-tax inequality, the redistributive effort can be smaller. Also, New Zealand spends a relatively large portion of its budget on social policies, though its efficiency in reducing inequality is limited.
Taxation of Saving
10. There are two broad concepts for taxing savings. In principle, the ‘expenditure tax’ system, where either savings or withdrawals of savings are taxed, is neutral between current and future consumption, while the ‘comprehensive income tax’ system in which returns to savings are also taxed is neutral between current consumption and saving (treating saving like any other form of consumption), which provides a (relative) disincentive to save (Whitehouse 1999).2 However, in practice, the effect on saving behavior and tax revenue depends on the progressivity of the income tax regime, the tax rates applied to contributions, returns, and/or withdrawals, and elasticities.
11. New Zealand’s tax system comes close to a comprehensive income tax system, and provides comparatively few incentives to save. Almost all OECD countries provide some incentives to increase private (retirement) savings: mostly contributions to specific pension funds are tax exempt, up to certain limits, (Yoo and de Serres, 2004) while some others (e.g., Australia) apply concessional tax rates to contributions, returns and/or payouts. In contrast, in New Zealand savings come out of after-tax income, and the returns to savings are taxed. However, the ‘Kiwisaver’ scheme provides some incentives for savings, including limits on the taxation of returns and some matching contribution (Box 1).
The Kiwisaver Scheme
In 2007, New Zealand launched the ‘Kiwisaver’ saving scheme, in an effort to raise low private saving rates. The scheme is voluntary, and incentives are provided. As of mid-2015, 2.5 million New Zealanders, or 69 percent of working-age adults, were enrolled in Kiwisaver. The main parameters are:
Enrolment for new employees is automatic, but opting out is possible.
Employees contribute 3, 4, or 8 percent of their income (self-employed or unemployed persons can contribute amounts agreed with their Kiwisaver providers). Contributions are taxed.
Employers compulsorily contribute 3 percent of the employee’s wage/salary. These contributions, while deductible for the employer, are taxed at the marginal income tax rate of the employee; hence the net benefit to the employee is smaller.
The government provides a 50 percent matching contribution in the maximum amount of NZ$521.43 per year, which is credited to the Kiwisaver account.
Prior to May 2015, to encourage uptake, the government also provided a one-time NZ$1,000 credit for new Kiwisaver members.
Funds from Kiwisaver accounts can generally be accessed upon reaching retirement age (65) at which the universal pension is paid. However, there are other circumstances under which Kiwisaver funds can be withdrawn: buying a first home, moving overseas, suffering significant financial hardship, or in case of a serious illness. Withdrawals are not taxed.
Kiwisaver members with incomes below NZ$80,000 (NZ$120,000 per couple) are also entitled to a ‘home start grant’ of up to NZ$5,000 for buying a first home (NZ$10,000 for newly constructed houses).
Taxation of Kiwisaver
(Average tax rate on total lifetime income) 1/
Citation: IMF Staff Country Reports 2016, 040; 10.5089/9781475522549.002.A003
1/ At 4% contribution rate.2/ The small t denotes the matching contribution provided.Source: IRD, Kiwisaver, IMF staff estimates.Average income during working life (NZ$)Taxation of Kiwisaver
(Average tax rate on total lifetime income) 1/
Citation: IMF Staff Country Reports 2016, 040; 10.5089/9781475522549.002.A003
1/ At 4% contribution rate.2/ The small t denotes the matching contribution provided.Source: IRD, Kiwisaver, IMF staff estimates.Average income during working life (NZ$)Taxation of Kiwisaver
(Average tax rate on total lifetime income) 1/
Citation: IMF Staff Country Reports 2016, 040; 10.5089/9781475522549.002.A003
1/ At 4% contribution rate.2/ The small t denotes the matching contribution provided.Source: IRD, Kiwisaver, IMF staff estimates.Average income during working life (NZ$)Overall, the financial incentives provided through Kiwisaver are significant, but could be higher.
As a result of the capped matching contributions and the limit on the top marginal tax rate, the incentive is similar to an exemption of contributions (at a 4 percent contribution rate—with a higher contribution rate, the incentive becomes smaller). Moreover, the matching contribution is more favorable for lower-income earners, who are more likely to add—as opposed to reallocate—savings (this depends critically on regular adjustment of the tax credit to keep pace with earnings). At the same time, the capping of the tax rate on returns favors higher-income earners. Overall, an exemption of savings returns (but taxation of contributions) would provide a higher incentive.
12. The evidence on the impact of tax incentives on saving is mixed. In principle, tax incentives for saving, since they raise the relative cost of consumption now against the cost of consumption in the future, should lead to higher saving. On the other hand, lower saving now is needed to reach a given level of wealth (and future consumption path), which could reduce saving. Moreover, if tax incentives are provided only for specific saving vehicles such as Kiwisaver they could lead to a reallocation of savings without increasing the overall amount. The empirical literature on this is inconclusive. While some studies (e.g., Gale and Scholz, 1994; and Attanasio et al, 2004) have found that tax incentives largely reallocate savings, others (e.g., Ayuso et al, 2007; Gelber, 2011) conclude that tax incentives create new saving, thus raising total saving. At the same time, there appears to be some evidence that tax incentives are most effective for lower- and middle-income households (e.g., Engen and Gale, 2000), though a significant—though smaller—contribution can also come from older high-income households (Ayuso et al, 2007).
13. Financial saving in New Zealand is disadvantaged compared to saving in the form of housing (see below). The returns on owner-occupied housing are not taxed at all (though interest payments on mortgages are not tax-deductible), while returns on rental housing are effectively taxed more lightly than those on financial assets, including shares, debt instruments, and bank accounts (Brook, 2014). Moreover, inflation has a different effect on real effective tax rates on different classes of investment, with housing again the most preferred.
Taxation of Housing
14. Many countries provide special tax regimes to support homeownership. While there may be good socio-political and economic reasons (e.g., promotion of homeownership as a social goal) for such policies, such special treatment can create significant economic distortions (some of which are indeed intended, though others are not), and are often costly in terms of foregone tax revenue. While estimates of distortions and the amount of tax expenditure are often of limited reliability due to the difficulty in quantifying behavioral responses to changes in policy, they can be substantial. However, beyond the direct fiscal cost effect, the support for homeownership also has an impact on the real estate market.
15. New Zealand’s tax and benefits system incentivizes investment in real estate. Both owner-occupiers and investors receive significant support relative to other forms of investment.
For owner-occupiers, investment in real estate is preferable to financial investments since no taxable income stream is generated—only potential capital gains that are not taxed. While demand for the overall number of dwellings might be only little affected (since people who do not own homes would have to rent), it is likely to lead to overinvestment in housing, and thereby drives up the value of dwellings. This in turn has potentially negative implications for housing affordability, equity, and financial stability.
For investors, interest payments and maintenance expenses are deductible from taxable income from other sources (though rental income is taxed). Moreover, there is no capital gains tax (CGT). While this treatment is not different from that of other investments (though uncommon internationally), it creates incentives to invest in real estate if capital gains are expected: when an investor expects capital gains, a property investment may be worthwhile even if rental income does not cover interest costs and maintenance expenses (‘negative gearing’). In an environment of rapidly rising real estate prices, the incentives for this form of investment increase, since untaxed expected capital gains increase. Negative gearing thereby acts as an amplifier of price movements in the real estate market and encourages investments that generate negative income streams but positive capital gains. At the same time, higher prices likely do not trigger a significant supply response, which is largely determined by more fundamental factors such as zoning regulations and infrastructure availability. While this tax treatment could subsidize rents, since at a given dwelling price it makes a lower rent acceptable to landlords, it also increases dwelling prices, with the net impact not clear.
16. Taxes on land (‘council rates’) are above the OCED average. They are levied by local authorities, and account for about half of all local government revenue (about 2 percent of GDP). Land taxes are most efficient, since they lead to virtually no distortions in economic behavior. While New Zealand’s revenue from land taxes are above average, those of some of its peers, including Canada, the United States, and the United Kingdom, are higher (Figure 5).
Land Taxes
Land taxes are above the OECD average.
Citation: IMF Staff Country Reports 2016, 040; 10.5089/9781475522549.002.A003
Source: OECD.Land Taxes
Land taxes are above the OECD average.
Citation: IMF Staff Country Reports 2016, 040; 10.5089/9781475522549.002.A003
Source: OECD.Land Taxes
Land taxes are above the OECD average.
Citation: IMF Staff Country Reports 2016, 040; 10.5089/9781475522549.002.A003
Source: OECD.The Pension System
17. New Zealand’s pension system is simple. The first pillar is the taxpayer-funded universal ‘NZ Superannuation’, which is paid to every eligible resident from age 65 onward. The second pillar consists of voluntary savings schemes, including Kiwisaver. In 1997, a proposal for complementing the first pillar with a compulsory retirement savings scheme (similar to Australia’s superannuation system) was overwhelmingly rejected in a referendum.
18. Superannuation is low but effective in supporting lower-income households
(Figure 6). It provides a uniform—i.e. not means-tested—income to everyone eligible (essentially, New Zealand residents over 65 years of age). The superannuation payments are about 40 percent of the average wage, which is fairly low by international standards. However, since the amount paid to pensioners is independent of previous (or current) earnings, while replacing about 80 percent of pre-retirement earnings of lower income earners, it replaces only a small portion of those of high earners, implying that they have to have additional savings to maintain their living standard after retirement.
The Pension System
Citation: IMF Staff Country Reports 2016, 040; 10.5089/9781475522549.002.A003
1/ Average of male and female.Source: OECD.The Pension System
Citation: IMF Staff Country Reports 2016, 040; 10.5089/9781475522549.002.A003
1/ Average of male and female.Source: OECD.The Pension System
Citation: IMF Staff Country Reports 2016, 040; 10.5089/9781475522549.002.A003
1/ Average of male and female.Source: OECD.C. Reform Options
Reforms to the tax and benefits system to support a rise in private saving and skew investment away from real estate, while also preserving adequate revenue, requires a comprehensive reform package.
19. New Zealand’s tax system is overall relatively efficient and simple; more so than many of its peers’. The ‘broad base, low rate’ approach pursued by the authorities has served the economy well, while New Zealand’s social benefits, though not very generous, broadly appear to contain inequality at levels close to the OCED average.
20. Any reform of New Zealand’s tax and pension system will need to reconcile competing objectives. Overall, the reform should (i) boost overall national saving, thus promoting higher growth and incomes in the long run (even though it may come at some expense to growth in the short run); and (ii) at least preserve, if not improve, socio-economic equality while maintaining or strengthening incentives for work and productive investment. Also, administrative costs for the state and compliance costs for taxpayers should be minimized. This requires a package approach consisting of simultaneous changes to several taxes, as well as transfers and Kiwisaver parameters. However, some elements could be introduced gradually to avoid penalizing existing interests which are the result of decisions made under the current tax system, and thereby increase social and political acceptability. Moreover, a package approach is needed to maintain at least budget neutrality so as to avoid offsetting higher private savings with lower public savings.
21. Not all reforms are equally critical. Some desirable changes may be politically more difficult than others to implement; therefore this paper presents a modular approach in which different options across and within modules can be combined. Nonetheless, key elements are linked, either because they are needed to balance revenue/expense additions and subtractions, or because they compensate for adverse effects of other policies. Some reforms are key building blocks without which not much else can be accomplished, while others are more of an auxiliary nature. Also, not all measures are tax measures; there are other options to tilt incentives toward higher saving. Table 1 provides an overview of reform options. Estimates (Table 1) are for the budgetary impact; the impact on the saving rate will depend on the combination of policies, as well as, critically, behavioral variables.
Impact of Tax Reform Options 1/
IMF staff estimates based on 2012/13 data from Treasury, Kiwisaver, Statistics New Zealand, and OECD data. Estimates are for first-round effects only.
Does not accrue to budget.
Expenditure measure.
Impact of Tax Reform Options 1/
| Measure | Impact on budget (% GDP) | |
|---|---|---|
| Total | ||
| Module 1: Strengthening Kiwisaver | ||
| Nonfinancial measures | ||
| Changing default settings (higher employee contribution rate, eliminating the lowest contribution rate option, reducing the duration of ‘contribution holidays’) | – | |
| Limiting access to funds before retirement | – | |
| Promotion of a wider variety of investment options | – | |
| Enrolment campaign | – | |
| Increase Kiwisaver employer contributions by 2 percentage points 2/ | 0.3 | |
| Reduce company tax by 2 percentage points (to compensate employers) | −0.4 | |
| Financial incentives | ||
| Exempting Kiwisaver returns | −1.2 | |
| Module 2: Other savings incentives | ||
| Reduce taxation of financial returns more broadly (-) | n/a | |
| Introduce means-testing for NZ Superannuation 3/ | 0.8 | |
| Introduce estate tax | 0.1 | |
| Module 3: Reducing investment demand for housing | ||
| Ringfencing housing losses (+) | n/a | |
| Widening the applicability of income tax on profits from property sales (+) | n/a | |
| Raising land taxes by one-third | 0.7 | |
| NET IMPACT | 0.0 | |
IMF staff estimates based on 2012/13 data from Treasury, Kiwisaver, Statistics New Zealand, and OECD data. Estimates are for first-round effects only.
Does not accrue to budget.
Expenditure measure.
Impact of Tax Reform Options 1/
| Measure | Impact on budget (% GDP) | |
|---|---|---|
| Total | ||
| Module 1: Strengthening Kiwisaver | ||
| Nonfinancial measures | ||
| Changing default settings (higher employee contribution rate, eliminating the lowest contribution rate option, reducing the duration of ‘contribution holidays’) | – | |
| Limiting access to funds before retirement | – | |
| Promotion of a wider variety of investment options | – | |
| Enrolment campaign | – | |
| Increase Kiwisaver employer contributions by 2 percentage points 2/ | 0.3 | |
| Reduce company tax by 2 percentage points (to compensate employers) | −0.4 | |
| Financial incentives | ||
| Exempting Kiwisaver returns | −1.2 | |
| Module 2: Other savings incentives | ||
| Reduce taxation of financial returns more broadly (-) | n/a | |
| Introduce means-testing for NZ Superannuation 3/ | 0.8 | |
| Introduce estate tax | 0.1 | |
| Module 3: Reducing investment demand for housing | ||
| Ringfencing housing losses (+) | n/a | |
| Widening the applicability of income tax on profits from property sales (+) | n/a | |
| Raising land taxes by one-third | 0.7 | |
| NET IMPACT | 0.0 | |
IMF staff estimates based on 2012/13 data from Treasury, Kiwisaver, Statistics New Zealand, and OECD data. Estimates are for first-round effects only.
Does not accrue to budget.
Expenditure measure.
22. A more comprehensive package is possible. Further shifting taxation toward indirect taxes, and lowering income taxes and company taxes, accompanied by compensating measures to protect low-income households would further increase the efficiency of the tax system. However, this paper concentrates on measures to address the most critical issues, namely raising savings, and making investment in non-housing assets more attractive.
Boosting savings
23. Raising private savings should be the centerpiece of any reform effort. While there is some ambiguity on the effectiveness of tax incentives to raise private savings, short of the introduction of a compulsory savings scheme there are no alternatives to providing incentives. This implies that they need to be carefully designed to maximize their impact. Overall, it may be worthwhile to concentrate efforts to increase saving on the Kiwisaver scheme, since this is relatively widespread, simple, and the ability to ring-fence it can be used to reduce possible unintended distortions that may arise from broader policies, such as a general reduction of the taxation of financial returns. To reduce the reallocation effect of a preferred savings scheme (where higher-income household do not increase savings but reallocate them to tax-preferred vehicles), caps on contributions/exemptions can be introduced (akin to the existing cap on the Kiwisaver matching contribution). Options include:
Module 1: Strengthening Kiwisaver
24. Non-financial measures. Not all incentives need to be financial. Changing key parameters in Kiwisaver could also achieve an increase in contributions and savings. For example:
Default settings. A higher employee contribution rate could be set as a default to ‘nudge’ participants toward saving more, while maintaining the option of reducing it. In addition, eliminating the lowest contribution rate option (currently 3 percent) would raise the floor of minimum contributions. Also, the duration of ‘contribution holidays’ could be reduced (while allowing to renew them), or the option eliminated.
Access to funds: Currently, Kiwisaver funds can be accessed before retirement in a number of circumstances, most notably for buying a first home. This could be reduced, while maintaining the ‘home start grant’ for low-income earners.
Increase compulsory employer Kiwisaver contributions. Current levels (3 percent) are exceptionally low compared to other countries. While a general compulsory Kiwisaver scheme may be politically difficult to achieve, an increase in the contribution rate for employers could achieve significant increases in saving (though some employees may, in response, reduce their own contribution). Such a measure—while its incidence would likely fall largely on employees—would tilt companies’ incentives toward lower employment and more use of capital. Nonetheless, the overall tax burden on companies would remain low (but could still be compensated for by reducing the company tax—see below). In addition, this could be counterbalanced by the overall macroeconomic effect of higher savings, cheaper capital, and more capital deepening. The cost for employers would amount to about 0.3 percent of GDP.
Investment options. Upon retirement, instruments to invest Kiwisaver funds are limited; e.g., there are almost no annuity products. Promotion of a wider variety of investment options could make saving and financial investment more attractive for individuals, and help deepen capital markets.
Enrolment campaign. While the majority of the workforce is already enrolled in Kiwisaver, a one-off campaign of automatic enrolment (with the possibility of opting out) could draw additional participants into the system.
Reducing company tax. To offset higher Kiwisaver contribution rates, the company tax could be lowered by 3 percentage points, bringing New Zealand’s company tax rate to the OECD average of 25 percent. This would more than counterbalance the increase in employer Kiwisaver contributions, though not eliminate the incentive to substitute capital for labor, and higher land taxes (see below) which would particularly affect farms. However, higher investment in response to higher saving would raise productivity and incomes. This would reduce revenue by about 0.4 percent of GDP.
Financial incentives. While non-financial incentives—in particular those that have a compulsory element such as raising minimum contribution rates—can have a significant effect on savings, financial incentives can complement these, in particular given that taxation of savings in New Zealand is relatively high.
Exempting Kiwisaver returns. The incentives under the current system of matching contributions and a cap on the top tax rate on returns for Kiwisaver members already closely mimics a system whereby contributions to the savings scheme are not taxed but returns are (ETE), and it benefits low-income earners more than those on higher incomes.3 Since most of the wealth in long-term savings accounts accumulates through compound returns and less from contributions (Savings Working Group, 2011), this system could be strengthened by exempting the returns on Kiwisaver accounts from taxation (TEE). This would, however, accrue mostly to middle- and higher income earners; to preserve the tilt toward stronger support for lower-income Kiwisaver participants, the matching contributions could continue to be paid while the exempted returns are capped. In a model calculation (with no caps on exempted returns), this would reduce middle- and high-earning individuals’ lifetime tax burden by between 1¾ and 2¼ percentage points (at 4 percent contribution rate; with higher contribution rates, the reduction would be higher), and for lower-income earners by 1 percentage point. The fiscal cost of exempting Kiwisaver returns depends crucially on the parameters chosen (i.e. with or without cap) and the current contribution rates of savers; the estimated cost could be about 0.9 -1.6 percent of GDP. Capping exempted returns would reduce this cost commensurately.
Module 2: Other savings incentives
Reducing taxation of financial returns more broadly. A broader reduction of taxation of saving could be achieved through the extension of the tax treatment of Portfolio Investment Entities (PIEs) to other forms of investment (all interest and dividends), as recommended by the Savings Working Group (2011). This would move New Zealand’s tax system away from the comprehensive income taxation model and toward the dual-taxation model prevalent in Nordic countries. While this would go some way to reduce the effectively higher taxation of financial savings on account of inflation, it would tend to benefit in particular high-income households whose saving decisions can be expected to be less responsive to incentives.4 As a result, it would require an overall higher redistribution effort to reduce the income inequalities arising from lower taxation of capital, as in Nordic countries that have adopted dual-taxation models.
Introducing means-testing for NZ Superannuation. The benefit of the universal pension for high-income households is relatively small. Means-testing NZ superannuation with a view of reducing payments for top income earners could provide an (albeit small) additional savings incentive for this income group, while saving public resources. If NZ Superannuation were to be reduced by 20, 40, and 75 percent to the top three income deciles, respectively, the fiscal savings would amount to about 0.8 percent of GDP.
Introducing an estate tax. An estate tax could increase saving to the extent that people take intergenerational welfare into account. In addition, it would improve equality of opportunity, reduce the intergenerational transmission of inequality, and incentivize work for the beneficiaries of inheritances. To avoid circumvention of the tax through gifting, time limits for the non-taxation of gifts could be used. However, the yield would likely be modest—data from other OECD economies suggest yields of about 0.1 to 0.2 percent of GDP (though some countries raise 03.-0.4 percent of GDP).
Reducing the supply-demand imbalance in housing
25. Reducing the preferential treatment of real estate would have multiple benefits. High investment in housing is not the same as real investment in housing, i.e. an increase in supply that would address shortages. Instead, high demand for housing has led to a spiraling of prices in the Auckland area, where one-third of New Zealand’s population lives, and amplifies price movements in the real estate market. To the extent that this demand is fueled by incentives in the tax/benefit system, the elimination or at least reduction of these incentives is desirable. In addition, a reduced allocation of savings to housing could free up savings for productive investment. Options include:
Module 3: Housing—reducing demand an increasing supply
Ringfencing housing losses. To reduce scope for negative gearing and speculating on capital gains and thus incentives for over-investment in housing, the deductibility of net losses from property investment from unrelated other taxable income should be abolished. However, to avoid distortions across asset classes, deductibility of interest costs from other taxable income when making financial investments should also be abolished.
Widening the applicability of income tax on profits from property sales. The recent introduction of a ‘bright-line’ test for levying income tax on profits from property sales for individuals—it is assumed that if a property is resold within two years, the intent of the initial purchase was to profit from a higher resale price and those profits are therefore taxable—is a step in the right direction. Extending the timeframe beyond two years would further reduce incentives to buy real estate as an investment opportunity (though not to the extent that the income stream is the primary goal of the investment). However, if the timeframe is lengthened, some form of indexation to avoid taxing purely nominal capital gains arising from inflation would need to be considered.
Raising land taxes. Taxes on an inelastic base—i.e. land—are most efficient. In addition, such taxes would, by increasing the recurrent cost of holding land encourage its development which would help alleviate housing supply shortages. However, an increase in land taxes would have distributional consequences: there would be a one-off loss in land value, which would be borne by the current owners. Therefore, a gradual increase may be desirable. An overall increase by one-third would bring New Zealand close to the top of OECD countries’ revenue from land taxes, and would yield about 2/3 - ¾ percent of GDP, though a lower increase could be envisaged depending on the fiscal impact of other, unquantified, measures outlined above.
D. Conclusions
Reforms to raise saving and reduce the bias of investment in housing can have multiple benefits, but these can be achieved only in a package.
26. The potential benefits of reform are significant. A comprehensive package aimed at boosting saving and making investment in housing relatively less attractive would (i) reduce external vulnerabilities arising from the large savings-investment gap; (ii) reduce domestic vulnerabilities by cooling the housing market in Auckland; and (iii) reduce capital costs and thereby boost New Zealand’s growth potential.
27. Reforms need to be pursued in a package. While not all reforms are equally critical, measures to increase saving as well as reduce incentives to invest in real estate, are important. Some changes, such as an estate tax, superannuation means-testing, or increases in land taxes, are likely politically controversial. Such measures need to be counterbalanced by other changes that may be easier to implement, such as exempting Kiwisaver returns or company tax reductions.
28. The reform package should be designed to be broadly fiscally neutral. Protecting the fiscal position and the public balance sheet is important to preserve New Zealand’s buffers; and if an increase in private savings is offset by a reduction in public savings, little is gained at the national level. However, the effects of reform on specific population groups (as well as overall) need to be analyzed more thoroughly. The fiscal impact estimates presented in this paper are relatively imprecise and need to be complemented by an analysis of the impact on saving.
Appendix—Technical Notes
This appendix provides technical explanations for the assumptions and calculation methods underlying the charts shown as well as the reform options discussed.
1. Figures
Figure 1, panel 1 (total levies): General government revenue (IMF data) plus employer contributions to autonomous pension funds (OECD data). 2013 or latest available data.
Figure 1, panel 2 (direct and indirect taxes): Direct taxes = total tax revenue minus taxes on goods and services plus employer contributions to autonomous pension funds (OECD data); indirect taxes = taxes on goods and services (OECD data). 2013 or latest available data.
Figure 2, panel 1 (personal income tax progressivity): OECD data on tax rates, GNI per capita based on IMF data. 2013 or latest available data.
Figure 2, panel 2 (tax wedges): OECD data on tax wedges, with employer contributions to autonomous pension funds (in percent of compensation of employees; OECD data). 2013 or latest available data.
Figure 3, panel 1 (GST/VAT productivity): Calculation based on OECD revenue data, and IMF final consumption data. 2013 or latest available data.
Figure 3, panel 2 (taxation of corporations): Corporate income tax (OECD data) plus social security contributions and employer contributions to private pension funds (OECD data) plus payroll taxes (OECD data). For Australia: subtraction of resource rent taxes; addition of royalties and resource rent taxes in separate series (state and Commonwealth budget data). For Canada, added royalties received by Alberta (Canadian authorities data). 2013 or latest available data.
Figure 4, panels 1-4 (inequality): OECD data.
Box 1: Modeled in real terms (excluding the effect of inflation). Assumptions: 35 years contribution, earnings increase at 2 percent per year; average lifetime earnings as indicated on x-axis; 20 years constant withdrawal to end balance of Kiwisaver account at zero. Kiwisaver returns: 4 percent per year.
Figure 5: OECD data.
Figure 6: OECD data.
2. Estimation of Impact of Reform Options:
Module 1
Exempting Kiwisaver returns. Calculated average income tax rates for each income decile (assumed to earn at average of income bracket); reduces them by percentage points indicated by calculations for Figure 7. Then calculates total income tax revenue without change, with change in effective income tax rate at 8 percent Kiwisaver contributions, and at 4 percent Kiwisaver contributions. The difference in income tax revenue between the average of the 4 and 8 percent contribution scenarios and income tax revenue without change is the estimated cost of the proposed policy.
Increase Kiwisaver employer contributions by 2 percentage points. Multiplies current contributions (from Kiwisaver data: http://www.kiwisaver.govt.nz/statistics/annual/) by 2/3.
Reduce company tax by 3 percentage points. Multiplies current company tax revenue (from Treasury data) by 2/28.
Module 2
Introduce means-testing for NZ superannuation. Calculates superannuation payments (from Treasury data) by income decile (assumes even distribution across top 8 deciles), then applies reduction indicated (20 percent for 3rd decile; 40 percent for 2nd decile, 75 percent for 1st decile).
Introduce estate tax: estimate based on other OECD economies’ estate tax revenue.
Module 3
Raising land taxes by one-third: Multiplies current land tax revenue by 1/3.
References
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Edward Whitehouse, The tax treatment of funded pensions, Social Protection Discussion Paper Series, No. 9910, The World Bank, Washington D.C., 1999.Yoo, K.-Y., and Alain de Serres, Tax Treatment of Private Pension Savings in OECD Countries, OECD Economic Studies No. 39, 2004/2, Paris 2004.
Prepared by Alexander Pitt.
Excludes local government revenues (consolidated fiscal accounts are not available). Local tax and other revenue amounts to another 3 percent of GDP. Nonetheless, even taking this into account, New Zealand’s level of taxation and other levies remain low.
Corresponding to the three points at which savings can be taxed (at the contribution stage, when investment income and capital gains accrue to the fund, and when payouts are made), systems are classified as TEE (contributions are Taxed, earnings are Exempt, payouts are Exempt), EET, TTE, or ETT.
At a 4 percent personal contribution rate. With a higher rate, the incentive smaller relative to that provided by an ETE or a TEE system.
See also IMF (2015) on the effect on different income groups of concessional taxation of superannuation contributions and returns in Australia. Australia’s system disproportionately benefits high-income savers.
